May 13, 2008 | Backgrounder on Latin America
These combines—in energy, telecommunications, construction, food production, broadcasting, financial services, and transportation—have long been a drag on competitiveness and job creation. Notwithstanding Mexico's membership in the North American Free Trade Agreement (NAFTA), this "roping off" of large sectors of the Mexican economy to benefit politically powerful rent-seekers has the same practical effect that traditional protectionist trade barriers have.
Calderón should also lead the fight to dismantle a state-corporatist system of price supports, subsidies, and special-interest tax exemptions that gives an unfair advantage to the wealthy and well-connected while restricting competition and holding down economic growth and job creation.
Evidence of the damage to the Mexican economy from the lack of competition can be seen in Mexico's ranking in the 2008 Index of Economic Freedom, published by The Heritage Foundation and The Wall Street Journal. Mexico's economy scored 66 of a possible 100 (with zero being "least free" and 100 indicating "most free"), making it the world's 44th freest economy out of the 157 countries ranked in the Index. It also ranked ninth out of 29 Western Hemisphere countries, well behind Canada, the U.S., Chile, and El Salvador.
Mexico's overall Index score is only marginally higher than the regional average in the Americas. In addition, although Mexico's overall score has improved slightly in the year since Calderón took office, it has not changed much in recent years, and this lack of change is due, at least in part, to the absence of any meaningful reform process.
The health of Mexico's economy has a direct impact on U.S. immigration patterns. The failure of the Mexican economy to perform at peak efficiency and to realize its full potential over the past half-century has resulted in a flood of unemployed semi-skilled and unskilled Mexican job hunters seeking employment with their alluringly successful neighbor to the north. Illegal workers from Mexico are often willing to accept lower wages than legal U.S. workers will accept. U.S. employers in various labor-intensive fields operate much more efficiently than their Mexican counterparts do, and these low-wage workers magnify that productivity. The artificially low cost of this labor (which also does not include all of the taxes necessary to offset the additional costs to the government that are generated by these new residents) has created a strong demand for illegal workers from Mexico.
To remedy this situation, the Mexican government should open its oil, natural gas, and electricity generation and distribution sectors to private investment and participation. It should also break up private-sector monopolies and duopolies with more effective anti-trust legislation. The U.S. government should offer technical assistance to help Mexico liberalize and open up its economy. The resulting flood of new private investment would create hundreds of thousands of new jobs that would encourage many would-be economic migrants to remain at home in Mexico.
"Supply Push" and "Demand Pull"
Immigration has become the most controversial, complex, and sensitive subject facing the United States today. It directly affects America's economy, culture, and future as a nation. Currently, anywhere from 12 million to 20 million illegal aliens reside in the United States—enough to populate America's three largest cities: New York, Los Angeles, and Chicago. An estimated half-million more people enter illegally every year.
As the Milken Institute's Joel Kurtzman has reported, former President Vicente Fox hoped to see 6 million jobs created during the six years of his presidency (2000–2006). Of course, neither presidents nor governments can create good sustainable jobs; only the private sector can do that. The role of government is to set policies conducive to that job creation. In any case, Fox "fell far short" of his goal:
Between 2000 and 2006…Mexico created only 1.4 million jobs. Though accurate figures are difficult to arrive at, the [U.S. Government] Accountability Office estimates that during each year of Mr. Fox's presidency between 400,000 and 700,000 illegal immigrants arrived in the United States from Mexico. The number of illegal immigrants from Mexico was roughly equal to the number of jobs Mr. Fox did not create.
If the Mexican government were to make the many changes needed to reduce the "supply push," and if the U.S. were simultaneously to make necessary changes in its immigration laws to weaken the "demand pull," there would be several positive developments. In Mexico, the result would be the creation of new, sustainable private-sector jobs. More Mexicans would want to stay home to start businesses, and others would stay to work for them. Some Mexican migrants currently working in the United States would very likely return home, using their savings to start small businesses.
On the U.S. side of the border, prospective employers of legal immigrants would be forced to pay the full, true cost of that labor, including taxes to offset the additional costs to the government that are generated by these new residents, thereby weakening the demand magnet. The result would be a lessening of migration pressures at the U.S. –Mexico border, a reduction in the U.S. unemployment rate, and improved U.S. national security.
Creating an Opportunity Society in Mexico
Under Vicente Fox, who governed Mexico and headed the center-right National Action Party (PAN) from 2000 to 2006, a divided Mexican Congress adopted some needed reforms after 71 straight years during which the center-left Institutional Revolutionary Party (PRI) had reigned supreme by controlling both the presidency and the Congress. The PRI, backed and financed inter alia by the Pemex and electricity workers unions, enjoyed such total control that pundits jokingly described Mexico as "the Soviet Union of the Western Hemisphere."
In December 2006, Fox's fellow PAN-ista, Felipe Calderón, succeeded him as president after barely defeating Andres Manual Lopez Obrador of the leftist Revolutionary Democracy Party (PRD). Lopez Obrador is from the same mold as Venezuelan dictator-president Hugo Chavez, and his election would have been a major blow to economic reform in Mexico as well as to the national security of the United States. Calderón, a lawyer who also earned a master's degree in public administration from Harvard University's Kennedy School of Government, had been President Fox's energy minister.
Mexico has benefited from its more than 10 years of membership in the North American Free Trade Agreement (NAFTA) with Canada and the United States. In fact, to some degree, Calderón can thank the thousands of new middle-class Mexican voters that NAFTA has created for giving him his razor-close margin of victory. They did not fall for the false promises of the populist left.
Nevertheless, the Mexican government has failed to implement fully the many reforms that were envisaged when Mexico joined NAFTA—reforms that would have created more opportunities for employment and prosperity in Mexico.
For example, of the 178 countries covered in the World Bank's Doing Business 2008 report, Mexico ranks 134th with regard to employment: Hiring employees is problematic, there are rigid restrictions on shift scheduling, and firing anyone is extremely difficult. Another economic performance indicator is Mexico's ranking in the Index of Economic Freedom, published by The Heritage Foundation and The Wall Street Journal. Although NAFTA membership has helped Mexico to improve its overall ranking from 85th of 160 countries in 1998, when it had just entered NAFTA, to 44th of 157 countries in 2008, it still places only ninth out of 29 Western Hemisphere countries, well behind Canada, the U.S., Chile, and El Salvador.
According to the United Nations Development Program'sHuman Development Index, Mexico ranked 53rd of 177 countries in 2006, which is relatively low for an emerging-market country and indicates a substantial poverty problem. Similarly, Mexico's "Gini coefficient," a measurement of income inequality, has not improved much over the past 10 years.
According to Inter-American Development Bank (IADB) statistics, Mexico's economy is heavily dependent not only on its commercial relations with the U.S., but also on the more than $24 billion in remittances that Mexican migrant workers in the U.S. send home each year. These remittances equal about "one third of the total wage earnings in the formal sector of the Mexican economy and 10 percent of Mexico's exports." Many observers believe the actual measure of annual remittances would be even larger if it measured the flows through other channels, like the unknown quantity of cash that migrants bring with them when they make visits back home, as well as money sent via the Internet and cash smuggled in by criminals. These channels are not reflected accurately in the official statistics.
In addition, recent reports indicate that the level of remittances may be falling, reflecting the economic uncertainty in the U.S. If so, this will put more pressure on the Calderón government to act quickly to reform the economy.
Tempted to Take the Easy Way Out
Historically, Mexican leaders have taken the easy way out—encouraging out-migration and receiving large inflows of hard-currency remittances in return—rather than confronting their economy's structural problems. In so doing, they took a page from the late Marshall Tito of Yugoslavia, who did the same thing when confronted with the failure of the Communist economic system in the 1970s. Tito simply exported his surplus workers to Western Europe.
While this artful dodging by the politicians has benefited the elites who control the monopolies, state-owned firms, and powerful unions that represent their workers, it has not responded to the needs and aspirations of the average Mexican citizen. Mexicans might be able to get higher-paying jobs in the U.S. as illegal aliens, but they must live in constant fear of deportation. Many of these illegal workers are young single men, the demographic most likely to commit crimes and abuse drugs and alcohol.
The failure of the Mexican government to address these problems has been widely noted. According to the U.S. Department of State, for example:
Mexico has become less competitive relative to other emerging economies, particularly China but also India and countries in Eastern Europe, as it has failed to address serious crime and safety issues or pass much needed fiscal, labor and energy sector reforms. Recent reports from AT Kearney, Transparency International, the World Economic Forum and the Organization for Economic Cooperation and Development (OECD) have detailed the perceived decline in Mexico's attractiveness as an investment destination.
Taking on the Drug Kingpins. Although President Calderón pledged during the 2006 presidential campaign to continue the modest economic liberalization efforts begun by Fox, he has spent more of his political capital on another worthy goal—fighting the dangerous and über-wealthy organized crime networks that traffic and ship illegal drugs through Mexico to the USA. This illicit activity is one of the main contributors to the pervasive atmosphere of corruption that has long plagued Mexico.
Calderón's efforts have had some success: The cartels are running scared and trying to shake Calderón's confidence with a series of brutal assassinations of Mexican law enforcement officers and military officials (and, in some cases, their families) who are involved in the fight against the narcoterrorists. But Calderón has not backed down. As Time magazine reported recently:
"When you see the killings, the cartels are trying to make a statement to the authorities not to interfere with their enterprises. And they are also trying to send a message to the public saying they are in control," said a U.S. anti-drug official…. "It's a P.R. campaign. But it's not going to work. Because, quite frankly, this country has a new sheriff."
Presidents Bush and Calderón recently announced a joint U.S.–Mexico program, the Mérida Initiative, to support the Mexican government in its war against drugs by providing U.S. technical assistance, training, high-tech surveillance equipment, and anti–money laundering financial intelligence software. Funding of $550 million for the second tranche of the three-year project was included in the Bush Administration's FY 2009 budget request to Congress. When added to the first appropriation for the Mérida Initiative that was requested in the FY 2008 War Supplemental, the total funding to date is $950 million for Mexico and $150 million for Central American countries to fight against drug-related gang violence.
A More Insidious Threat: Economic Stagnation. Mexicans are still waiting to see whether the Calderón government will bring the same degree of commitment and resolve it has demonstrated in the drug war to the many systemic and structural problems that historically have prevented the Mexican economy from performing anywhere near its full potential. At growth of just 3 percent, Mexico's roughly $900 billion economy lags behind both Brazil (4.5 percent) and the overheated, poorly managed Argentine economy (a sizzling 8.5 percent).
Calderón is acutely aware of the huge growth opportunities that Mexico is missing domestically, as well as Mexico's increasing vulnerability to competition from Asia, and has proposed an ambitious package of reforms to the Mexican Congress. Calderón's reputation as a pragmatist may help him strike a political deal with the lawmakers. The PRI's nearly 80-year hold on political power in the Congress through deeply entrenched, well-connected economic monopolies, however, is proving difficult for Calderón to unravel.
In a hopeful sign, Calderón recently announced the creation of a $25 billion fund to build highways, bridges, and other infrastructure. As the Los Angeles Times reported, Calderón wants to avoid dependence "on the external motor of the U.S. economy" to keep Mexico growing. He also warned that Mexico must make "difficult decisions" to reverse the decline in Pemex's production and to raise funds from a source other than the government budget to "pay for exploration in the deeper waters of the Gulf of Mexico." The money, Calderón said, could come only from two sources: reducing government spending for public services or looking to the examples of China, Norway, and Brazil, where the state-owned oil companies benefit from private investment.
President Calderón faces an uphill fight to win reforms from the divided Mexican Congress to permit greater private investment in the energy sector. The opposition, including entrenched special interests in the PRI and anti-globalization activists in the PRD, will try to "forestall reaching the two-thirds majority needed to change Mexico's constitution and allow for participation of private companies in oil exploration and production."
A Choke-Hold on the Mexican Economy
Numerous private- and public-sector monopolies—in energy, telecommunications, construction, food production, broadcasting, financial services, and transportation—have long been a drag on competitiveness and job creation in Mexico. The oil firm (Pemex) and electric power company (Federal Electricity Commission) are both state-owned monopolies, and neither one has been disciplined by competition. Massive privately owned firms have functioned like monopolies and duopolies in telecommunications (Telmex); television networks (Televisa); cement (Cemex); bread and tortilla manufacturing (Bimbo and Maseca, respectively); and banking (Banamex/Citigroup and Bancomer/Banco de Bilbao). They enjoy monopoly rents by using their significant influence with the Mexican government to stifle competition.
As a result, Mexican consumers pay higher prices for a lower quality of service and reduced availability of goods. In addition, Mexico's state-corporatist system of price supports, subsidies, and special-interest tax exemptions gives an unfair advantage to other wealthy and well-connected businessmen while restricting competition and obstructing economic growth. Of course, the most critical result for Mexico's workers is a severe shortage of jobs.
Mexico's largest unions have had a stranglehold on the Mexican labor sector since the 1930s. Granted immense leverage in workplaces, as well as tremendous resources and political power, they enjoy "closed shop" hiring and firing prerogatives, leadership elections by acclamation, and mandatory dues without transparency.
"Although union membership is gradually declining," reports the Economist Intelligence Unit, "the percentage of unionized workers remains above 30 percent," mostly "at industrial plants employing 20 or more workers. Independent unions are rare in Mexico." The majority of workers belong to one of only nine national labor unions, which "enjoy strong political ties and are often organized to rally in support of a politician's campaign. Likewise, a politician who confronts unions can expect to face union-led street protests."
The economic stagnation that has resulted in part from the structural distortions to the economy caused by the rigid labor market has forced 40 percent of Mexico's workers into the informal sector.
The immense political power of the National Educational Workers' Union (a teachers' union with about 650,000 members and the largest labor union in Latin America), or the oil workers' union (the richest in Latin America), or the social security employees' union (which has thwarted any attempt at pension or health reform for years) remains largely unchecked. Even a weak attempt at reforming the labor market by "the Fox administration— which avoided sensitive measures, such as linking wage rises to productivity increases—was rejected" due to "the lobbying power of the influential public-sector unions." This locked-down situation leaves legions of informal and part-time workers out in the cold.
The remittances that Mexican workers in the U.S. send home to their families are spent mostly on goods and services. If a portion of this money could be drawn into investmentsto start small and medium-sized businesses in Mexico, and if those investments could be made in the context of a reformed domestic economic environment, the resulting economic stimulation and job growth would reduce out-migration pressures significantly. This could be achieved if Mexico's federal and state governments adopted pro-growth economic policies centering on job creation, robust free-market competition, monopoly-breaking privatization of public-sector enterprises, and anti-corruption measures.
Case Studies in the Need for Reform
Mexico showcases numerous examples of the negative economic effects of monopolies and duopolies. It is virtually impossible for a company to break into certain markets—beer, cement, textiles, or bread among them. According to the Economist Intelligence Unit:
[The Mexican government owns] oil and other hydrocarbons; basic petrochemicals; electricity; radioactive materials; and nuclear energy. Other state-run sectors include the following: airports, seaports and heliports; postal service; telegraph; radiotelegraphy; minting and issuing of paper money; and certain mining areas. The government also manages Mexico's development and trade banks, including the North American Development Bank, created alongside the North American Free-Trade Agreement (NAFTA) to provide financing to environmental-infrastructure projects along the U.S.–Mexico border.
The Mexican Congress awarded no-cost broadcasting frequency spectrum to just two politically well-connected companies: Televisa and its only rival, TV Azteca. The airline industry was opened up, but only slightly. The two major national air carriers, Mexicana and Aéromexico, were privatized in the 1980s but reacquired by the Mexican government in the 1990s after they experienced financial difficulties. Within the past few years, they have been sold again to private interests, but they continue to operate as a duopoly and exert their market power to block the entry of any significant competition.
Further evidence of the need for extensive reform is provided by three major industries—oil, telecommunications, and electricity—that are sorely in need of competition.
Pemex: Mexico's Tarnished Crown Jewel. In analyzing where reforms are needed most, a natural starting point is Mexico's oil sector, which accounts for a substantial portion—9 percent in 2006—of the country's gross domestic product. State-owned Petroleos Mexicanos (Pemex) has a monopoly on all upstream and downstream exploitation of Mexico's rich oil and natural gas resources, although the Mexican constitution specifically reserves only "ownership of…petroleum and other hydrocarbons" for the state. According to several business scholars, it does not mandate the state monopoly of oil production and retail.
The oil and gas sector has been extremely sensitive politically at least since the 1930s and the sexenio of the revered Lazaro Cárdenas. Control of the oil industry strikes at the very heart of the average Mexican's sense of sovereignty, national self-image, and independence from the U.S. (which invaded Mexico several times in the 19th and early 20th centuries).
In 1938, President Cárdenas created Pemex by nationalizing the holdings of U.S. and Anglo–Dutch companies that had largely developed Mexico's oil industry. In his seminal book on the world petroleum industry, The Prize, Daniel Yergin writes that "petroleum nationalization [was the] great symbolic and passionate act of resistance to foreign control, which would become central to the spirit of nationalism that tied [Mexico] together."
Rather than working for the Mexican people, however, Pemex seems to exist primarily to generate revenue for the government treasury and for its own union. With almost 140,000 workers, Pemex is wildly overmanned. Its pre-tax earnings in 2007 were around $50 billion, but it invested only $13 billion in development of new oil fields. As a result, oil production is already falling and will continue to decline rapidly unless new deep-water discoveries of proven oil reserves are made in the Gulf of Mexico or Mexico's Pacific waters. Pemex replaces only a fifth of the reserves it depletes, and Mexico already imports 30 percent of the petroleum and 23 percent of the natural gas that it consumes. According to BusinessWeek:
Mexico's largest potential reserves are believed to be located in the deep waters of the Gulf of Mexico, as much as 10,000 feet below the surface. Pemex does not have the technology or the expertise to go after that deepwater oil. Over the past five years, it has drilled six test wells in waters about 3,000 feet deep, finding some gas, but it needs the help of international oil companies, such as Brazil's Petrobras (PBR) or Norway's StatoilHydro (STO), to mount a concerted deepwater campaign.
Although the Pemex monopoly ensured national sovereignty, it came at a high price, feeding an unfortunate pattern of widespread and heavy-handed government involvement in the economy, as well as generating substantial graft and corruption. Former Federal Reserve Chairman Alan Greenspan characterizes Cárdenas's behavior as defiantly anti-American and observes that "[h] is action had dire long-term consequences for Mexico."
The Mexican Congress has taken some timid steps to increase private investment in the energy sector, but not nearly enough market incentives have been put into place to spur necessary competition in such a vital sector of the economy. This has led to a Pemex that is "inefficient, undercapitalized and utilized as a golden goose by the government," whose "existence exacerbates corruption." In the 2000 election, according to some observers, Pemex funds wound up in the coffers of many PRI candidates. By 2000, the PRI had exercised a political monopoly in Mexico for 70 straight years, since the time of President Cárdenas. The PRI power base rested (and continues to rest) heavily on Pemex and the Pemex workers' union. An almost identical and equally negative phenomenon can be observed today in the Venezuela of Hugo Chavez.
"Pemex resembles a poorly run government ministry," according to The Economist. "Its past three chief executives have all been accused of corruption," and the company "must comply with onerous procurement rules meant to prevent graft, which in practice are merely a drag on getting things done" (and clearly have not achieved their objective of eliminating corruption within Pemex). According to Joel Kurtzman, Pemex is also "the world's most heavily indebted oil company," "one of the [world's] least efficient producers," and "so bogged down by bureaucracy, conflicting interests, political meddling and sweetheart union deals, that it has failed to find any new oil reserves in years."
Professor Rafael Pampillón of the Instituto de Empresa graduate business school in Spain has noted that:
[A]ll the gas stations [in Mexico] are PEMEX. It is a good idea to provide PEMEX with higher tax revenues but it is much more important to improve competitiveness in the [energy] sector by permitting the arrival of companies from other countries—and even by privatizing PEMEX, although the current practice [of state control of PEMEX] is deeply rooted in Mexican tradition.
Pampillón argues that more competition in the Mexican energy sector would benefit the entire country.
The PRI members of the Mexican Congress are fiercely resisting even the minor Pemex reforms that President Calderón is proposing. The reason, as noted by The Wall Street Journal's Mary Anastasia O'Grady:
[T]he guardians of the status quo—politicians, suppliers and labor—would suffer if competition hit the market. Private Mexican contractors who "supply" Pemex are [accustomed] …to business transactions tied to political connections. If there were multiple buyers in competition with one another, those political profit margins would evaporate.
That benefit will be realized if President Calderón overcomes PRI resistance and speeds up efforts at reform of Mexico's energy sector to help it catch up with the majority of other producer countries. Although some "important changes have been introduced to attract private investment in natural gas transportation and distribution":
[The most important] issue in the immediate term will be the evolution of competition in the market. Hence, one of the first issues to be tackled to enhance the role of market forces in the sector is Pemex' discretionary discounts on domestic gas and access to transport services made possible by its monopoly in domestic production and its overwhelming dominance in [pipeline] transport.
Telmex: Toothless Regulation That Fleeces Mexican and U.S. Consumers. The telecommunications sector presents what is probably the best case study of the distorting impact of monopolies on the Mexican economy, in this case the de facto monopoly controlled by Grupo Carso, the privately held firm owned by Mexican billionaire Carlos Slim and his family. Through his ownership of the former state-owned monopoly Teléfonos de México (Telmex), which had been Mexico's "Ma Bell," Slim owns more than 90 percent of Mexico's fixed telephone landlines, and "[h] is America Movil's Telcel unit has 77 percent of wireless subscribers in the country."
Compare that to the United States, where four well-regulated national cell phone carriers compete ferociously and drive down prices paid by consumers. Telmex and Telcel dominate the telecom industry and wield "significant influence over key regulatory and government decision makers." Telmex has often been accused of finding innovative ways to block the entry of competitors. As Mary Anastasia O'Grady has noted in The Wall Street Journal, "Mr. Slim's company has been masterful in protecting its turf. One example is its success in using endless litigation to fend off regulatory orders that it provide interconnections to other carriers at fair rates, as required by law."
"Mexico lacks a competition culture," according to the Paris-based Organisation for Economic Co-operation and Development (OECD). "The Federal Competition Commission is fairly toothless," says The Economist, "though a new law is supposed to give it more bite. Some analysts are hoping that technological innovation will undermine Telmex's monopoly. But it is seeking to expand into new businesses, such as cable television."
In 1999, the U.S. Federal Communications Commission accused Telmex (and then-partner Sprint) of "anticompetitive practices in the long-distance market" by overcharging Mexicans in the U.S. when they called home to Mexico. "U.S. consumers have to pay much more than they should to reach friends and relatives in Mexico," said then-FCC Chairman William E. Kennard. "The carriers have not moved quickly enough to bring these rates down and ensure meaningful competition." The U.S. government complained about the Telmex practices to the World Trade Organization, which ruled against Telmex in 2002.
Critics complain that Slim's competitors have been "victimized" by his cynical "manipulation of Mexico's weak regulatory agencies and arcane laws," especially his notorious abuse of the amparo, or injunction, which allows any citizen who feels that a government decision violates his constitutional rights to ask a judge to delay its implementation—often for years.
Since 1998, Slim has made use of more than 60 amparos to thwart decisions by Mexico's antitrust agency, the Comisión Federal de Competencia, ordering Telmex to reduce its interconnection rates—the fees rivals must pay to use Telmex trunk lines. "Telmex's very aggressive use of the amparo has ended any hope of an open telecommunications market in Mexico," says Karina Duyich, [former head of] AT&T Mexico's legal department.
Carlos Slim: Mexico's Fattest Cat. Perhaps the wealthiest person on the planet, Mexican telecommunications mogul Carlos Slim has been chastised for his lack of charity. Slim, whose father immigrated to Mexico from Lebanon, controls companies that account for one-third of the investment value of the $400 billion Mexican Bolsa (stock exchange).
Slim, 68, amassed his nearly $60 billion fortune in a nation where per capita income is less than $6,800 a year and half the population lives in poverty. His wealth amounts to 6.3 percent of Mexico's annual economic output: If Bill Gates owned a similar chunk of the U.S., he would be worth $784 billion. According to one account:
[I]t takes about nine of the captains of industry and finance of the 19th century and early 20th centuries—Rockefeller, Cornelius Vanderbilt, John J. Astor, Andrew Carnegie, Alexander Stewart, Frederick Weyerhaeuser, Jay Gould and Marshall Field—to replicate the footprint that Mr. Slim has left on Mexico.
As another observer has written, that's "enough to give any populist heartburn."
The cash from Telmex has financed relentless diversification. Slim's America Movil is the largest mobile-phone operator in Latin America. His family also holds a string of industrial and retailing businesses, including the Mexican operations of Sears. He is the biggest tenant in the country's shopping centers. His latest venture is Ideal, an infrastructure company working mainly in the oil industry. He is also the second-largest shareholder in Televisa, Mexico's television giant. In addition to landlines and cellular, Telmex also enjoys an important share of the broadband Internet market and is trying to become a dominant force in Mexico's pay-TV market. Telmex also has huge business holdings in the U.S. as well as in other South American countries.
Professor George W. Grayson, an expert on Mexico at the College of William and Mary, coined the term "Slimlandia" to describe how entrenched the Slim family's companies are in the daily lives of Mexicans. It is not a reverential term. Many Mexicans hoped that privatization, which began in the early 1990s, would create competition and drive prices down drastically, but that has not happened. "Slim is one of a dozen fat cats in Mexico who impede that country's growth because they run monopolies or oligopolies," says Grayson. "The Mexican economy is highly inefficient, and it is losing its competitive standing vis-à-vis other countries because of people like Slim."
Telmex Privatization: A Sweetheart Deal. As a recent report by the OECD Economics Department notes, "Mexico remains one of the OECD countries with the highest charges, especially for business use. In the mobile telephone market, in particular, the dominant firm [Telmex] is using its market power to squeeze out other players." Clearly, the many customers who are being held hostage to both Telmex and Telcel are not getting their money's worth for the high prices they pay. The government of then-President Carlos Salinas de Gortari did very little to reform or modernize Telmex when it was privatized in 1990 during the Mexican government's preparations for entry into NAFTA. The Salinas administration simply issued regulations that protected the Telmex long-distance service monopoly until August 1996.
In participation with minority partners France Telecom and Southwestern Bell (now AT&T), Slim acquired a 51 percent voting interest in Telmex, representing over 20 percent of the equity in the company. Although he denies accusations that Salinas gave him special treatment, Slim was able to buy Telmex from the government for just $1.7 billion.
Rumors about the details of the Telmex purchase have swirled ever since then. Slim was a member of Salinas's inner circle and attended a legendary 1993 dinner at which Salinas purportedly asked each guest to contribute $25 million to his PRI party's war chest in return for favorable treatment during the coming wave of privatizations. "Although no evidence has emerged, many Mexicans suspect that Mr. Salinas secretly profited from the sale of Telmex."
Telmex service was terrible in 1995 when Slim took over. Although service improved after he "plowed more than $16 billion into the carrier to upgrade infrastructure and improve customer service," Carlos Slim continues to abuse his monopoly position, overcharging both Mexicans at home and those in the U.S. trying to call home.
Poor Telmex service is one of the leading complaints received by Profeco, Mexico's Federal Consumer Protection Agency. Under pressure in part from increased competition from such long-distance Internet phone service providers as Skype and Vonage,Telmex has publicized the fact that it has not raised rates for basic landline service for eight years, which has hurt profit margins but blunts political efforts to break up the company. Meanwhile, Skype and Vonage have alleged that Telmex has attempted to block their service to Mexico.
Teledensity (the number oflandlines per capita, close to 100 percent in the U.S.) in Mexico, at 19 percent, is among the lowest in Latin America because of the artificially high prices that Telmex charges and the lack of competition. This low level of interconnectedness is another major factor holding back Mexico's development.
Telmex owns and operates international businesses including fixed-line and wireless operators, television cable companies, and Internet service providers in Brazil, Argentina, Chile, Colombia, Ecuador, and Peru. These businesses account for about 30 percent of Telmex's total revenue. In 1995, government regulators allowed Telmex to buy a 49 percent stake in Cablevision, the cable-television division of Mexico's media powerhouse, Televisa. Telmex has been criticized by competitors and legislators for using its influence to head off stronger regulation. Analysts say the problem is Mexico's weak regulatory framework.
Reforms to curtail Telmex's monopoly power during the Ernesto Zedillo and Vicente Fox administrations (1994 to 2006) yielded modest reforms at best. As recently as October 2007, an OECD report concluded that Mexico must do more to increase competition in its energy and telecommunications industries. Additionally, "OECD noted that telephone costs in Mexico are among the highest among OECD member countries in terms of purchasing power parity." Clearly, Mexicans would be well served by increased consumer choice and a more robust and transparent telecommunications sector.
In October 2007, Mexico's Federal Competition Commission (CFC) began an investigation of Carlos Slim for alleged monopoly practices, trying "to determine whether the two companies, owned by Slim, America Movil and Telmex have a monopoly on the Mexican market."
Splitting up Telmex Would Create Jobs. BreakingTelmex's vise-like grip on Mexico's telecommunications sector would create new, sustainable, well-paying jobs for Mexicans in Mexico. A recent paper by two prominent World Bank scholars, Isabel Guerrero and Luis Felipe Lopez-Calva, underscores this point:
Many studies confirm that lack of competition is a crucial problem holding back the possibility of strong growth in Mexico. The Mexican Competitiveness Institute (IMCO) developed a model to assess the main factors behind the low and failing competitiveness [in] Mexico. Drawing on cross-country information, they estimated point elasticities for the impact of investment per worker of a ten percent [sic] in different dependent variables. The top four interventions which would bring about an improvement in competitiveness in Mexico are: (i) improvements in the competition environment; (ii) changes in taxes and tax regulations; (iii) improvements in administrative regulations and the investment climate; and (iv) education.
An Inefficient, State-Owned Electricity Monopoly. Mexico's national sovereignty sensitivities historically have extended beyond the oil patch to embrace the entire energy sector, which Mexicans have considered strategic. During the nationalistic "import substitution" craze that swept through Latin America in the 1960s, the Mexican government chose to nationalize the country's electricity production and distribution companies, imposing limitations on private participation and foreign companies' ability to operate. They are permitted to do so only through specific service contracts with the Federal Electricity Commission (CFE) and Luz y Fuerza del Centro (LFC).
The electricity sector is federally owned, with the CFE having exclusive rights to provide electric services throughout Mexico. The CFE is one of Mexico's largest companies. According to the Economist Intelligence Unit:
[Its monopoly status is] embedded in the Mexican constitution and is defined by its Electricity Law. CFE is vertically integrated and provides generation, transmission and distribution services for all of Mexico with the exception of electric distribution in the Mexico City metropolitan area. Luz y Fuerza del Centro (LFC), another wholly owned decentralized agency of the Mexican government, is responsible for the distribution of electricity in Mexico City and purchases some of its power from CFE.
Past attempts at reform have been met with strong political and social resistance in Mexico, where electricity subsidies for residential consumers absorb substantial fiscal resources. Meanwhile, Mexico's power generation sector is failing to install sufficient additional power generation to meet future needs. Historically, political constraints have meant that any funding to increase generating ability had to come from the already overextended federal budget. Nevertheless, a recent report by the Mexican energy ministry shows that between 2009 and 2014, a substantial amount of new generating capacity will have to come from private investment in order to meet demand.
A good illustration of Mexico's highly politicized energy regulatory environment occurred in 2004 when leftists in Congress, who oppose even the slightest degree of energy privatization, filed a complaint with the Auditoría Superior de la Federaçion (ASF), asking it to review the legality of those few generation permits that had been granted by the Comisión Reguladora de Energá (CRE) to private parties. The ASF found that the generation permits granted by the CRE were illegal and contrary to the constitution. The energy ministry filed a constitutional challenge before the supreme court alleging that the ASF does not have authority to decide on the legality of the generation permits granted to private parties by the CRE, and the supreme court agreed to hear the case, thereby tying up the permits for lengthy periods of litigation.
President Zedillo, a Yale-trained economist, proposed a complex set of reforms in 1999 that would have led to the sale of the CFE and LFC, but the Congress killed the reforms. "An electricityreform package that would have strengthened the legal framework and facilitate growth in privateinvestment was proposed by the Fox administration," according to the Economist Intelligence Unit, "but was blocked. The Calderón administration hopes to push a similar project through [in 2008] ."
Increasing private participation in the electricity sector would also help Mexico to do a better job of controlling air pollution, for which Mexico City is justly infamous. According to a study by the International Energy Agency, Mexico is one of the 10 worst polluters among developing countries. Generally, only countries with a high degree of economic freedom and market-based democracy have the means to spend the large sums required to clean the air.
Other Obstacles to Reform
Mexico's Plutocracy. For any of its reform measures to succeed, the Mexican government must dismantle the country's corporatist system of price supports, subsidies, and special-interest tax exemptions. This system has evolved over many years in an incestuous atmosphere of collusion among senior government, labor, and business elites.
Among the primary systemic failures of Mexico's current political arrangement is the control that key economic actors in the private sector exercise over the country's legislative and executive bodies. In effect, Mexico is governed by a permanent and unelected plutocracy. The wealth of the country is concentrated in the hands of too few individuals.
Failure to Protect Intellectual Property Rights. If the monopolies can be reined in, not only will domestic competitors benefit, but so will foreign competitors. There is another problem, however, that is impeding foreign investors.
In order for Mexico to attract additional foreign direct investment (most notably in telecommunications and energy), it must strengthen enforcement mechanisms to protect intellectual property rights. By placing Mexico on its Special 301 Watch List in 2007 for the third year in a row, the Office of the United States Trade Representative (USTR) rebuked the Mexican government for its weak enforcement of intellectual property rights.
Inadequate Highways and Other Infrastructure Problems. As noted by the OECD, the competitiveness of Mexican firms is being hampered by the poor quality and high cost of transportation, which are also disincentives to foreign investment and to Mexico's productivity growth:
The road network and trucking are plagued by inefficiencies and there are border issues that need to be addressed. The government is committed to further developing road infrastructure through public-private partnerships and concessions for toll roads. Clarifying long term government plans would help private sector involvement.
Additional detail is provided by the Economist Intelligence Unit:
Mexico's road network stood at 355,796 km in 2005, including 122,677 km of paved roads and 14,874 km of major road systems. Poor coordination at the state and federal level has resulted in poor planning of the road network [in the 1990s] and in maintenance problems. Mexico's roads and highways are still inadequate in the more remote parts of the country…. It continues to prove difficult to attract private capital to road building, maintenance and operation; in addition, government auctions for road concessions are complicated.
Subsidies. Although President Calderón is trying to reform the energy sector, these reforms are doomed to fail unless he is able first to address the excessive government subsidies for that sector. According to a 2007 study by the International Association for Energy Economics, electricity prices in Mexico are "heavily and unevenly subsidized"— the average electricity subsidy is 30 percent of non-discounted retail rates, and residential subsidies are more than 50 percent. To offset the cost of the subsidies, excessively high energy prices are charged to those businesses and consumers that do not receive subsidies, and those high rates are "hurting the competitive position of Mexican industries."
These subsidies are also hurting the government's budget, frittering away resources that could be used more productively to improve infrastructure. "In 2007," reports the Financial Times, "the Mexican federal government…earmarked 105.6 billion pesos to subsidize power consumption, which is equal to 1.1 percent of Mexico's gross domestic product (GDP)."
Mexico's Political Oligopoly. For 70 years, just one party—the PRI—had a complete lock on Mexican politics. Now three parties share the power, but no fourth party can enter the political arena or have access to the taxpayer subsidies handed out to these three (to the tune of more than half a billion dollars in 2007) without their consent.
Independent candidates are not allowed to run. The absence of consecutive re-election at any level reinforces the party machines' power: They pick candidates to run for all local and state offices who are then merely ratified by the voters at the polls. The only primaries or conventions that are held are to determine candidates at the national level.
Political Reforms Blocked. Last year, President Calderón won approval from Congress for a package of fiscal reform measures intended to increase non-oil tax revenue by 2 percent of Mexico's GDP. Its approval gives the president political momentum as he seeks the energy reform that is next on his agenda in 2008. But this victory came at a price: The president was forced "to acquiesce in an opposition-inspired constitutional amendment on electoral reform" that is "the legacy of last year's bitter presidential election, in which Mr. Calderón narrowly defeated Andrés Manuel López Obrador of the center-left Party of the Democratic Revolution (PRD)."
Does Mexico Need a Teddy Roosevelt?
In the late 19th and early 20th centuries, the United States faced similar challenges. President Theodore Roosevelt pressured Congress to implement existing anti-trust legislation (e.g., the Sherman Anti-Trust Act of 1890) and to pass additional measures, such as the law that created the Interstate Commerce Commission. By doing so, Roosevelt led the U.S. government to stand courageously against powerful banking, oil, and steel magnates of the day and enforce regulations and laws to curb the power of monopolies to choke off competition and hamper free-market operations.
Although President Roosevelt's name is most often associated with trust-busting in the U.S., his successor, William Howard Taft, broke up twice as many trusts during his tenure. Rather than encouraging unnecessary and burdensome regulations, Roosevelt and Taft used governmental powers in the manner envisioned by the Founders to create a space where competition could provide American consumers with the best goods and services at the lowest price.
The head of Mexico's Federal Competition Commission, Eduardo Perez Motta, recently announced that his agency (the equivalent of the Anti-Trust Division in the U.S. Department of Justice) will re-open an investigation of Carlos Slim's telephone companies, Telefonos de Mexico and America Movil. Slim's empire today is far greater than even John D. Rockefeller's at the time of his death in 1937. If President Calderón can be Mexico's Teddy Roosevelt, perhaps Mr. Perez Motta can become Mexico's President Taft.
Calderón himself is on record as supporting the changes that he knows are needed: "As the head of Mexico's energy sector [2003–2006] , he promoted the modernization of state-owned companies as president of the Board of Directors of PEMEX, the Federal Commission of Electricity (CFE) and the electricity company Luz y Fuerza del Centro (LyFC)."
A Transformed Mexico Would Help Everyone
The prosperity and national security of the United States have already been enhanced by the progress made by Mexico since it joined NAFTA in 1994. For further progress, however, the barriers to entry into the marketplace of political ideas also have to come down.
What is required is a careful examination of the vast areas of Mexico's economy that are state-owned or where private monopolies and duopolies are permitted by the state to operate without competition. Attention must also be given to labor laws that hobble the indigenous workforce and force millions into the informal economy, as well as to the political straightjacket that has bound Mexico's leadership. These reforms will require a level of political will by all Mexican politicians that is strong enough to break these shackles and create an atmosphere that fosters greater economic opportunity.
This would, of course, be a daunting task at every level, perhaps even a dangerous one. But it is not impossible. The result would be a transformed Mexico—a Mexico that has never before existed, that attracts workers with its economic opportunities rather than repelling them. The pressure on the U.S. border would ease considerably and might even disappear.
With strong personal leadership that inspires the Mexican population, a coalition with the political will to persist just might be forged. President Calderón, were he to succeed, would be hailed as the Teddy Roosevelt of Mexico, and Mexico and the United States would both be the better for it.
What Needs to Be Done
The Mexican government should open its nationalized oil, natural gas, and electricity sectors to private investment and participation. Pemex, for instance, should consider leasing deep-water areas under its control in the Gulf of Mexico to private oil companies to develop the fields, sell the oil produced, and pay royalties from their profits to the Mexican government. Private electricity-generating companies in Mexico and the U.S. should be encouraged to sell power to the two state-owned companies, the Federal Electricity Commission and Central Power and Light, and to invest in building additional power-generating ability in Mexico.
The Mexican government should break up private-sector monopolies and duopolies by passage, implementation, and enforcement of more effective anti-trust legislation.
The Mexican government should enforce its laws more aggressively to protect all intellectual property rights, for Mexican as well as for foreign rights holders, by increasing funding and staffing of the three relevant government agencies (the Office of the Attorney General, the Mexican Institute of Industrial Property; and the National Institute of Author Rights). The government should also increase training for Mexican police and the Mexican Customs Service to spot IPR violations and take enforcement actions.
The Mexican government should eliminate the distortionary price controls and subsidies that have tilted the competitive playing field toward monopolies and duopolies in numerous sectors of the economy, especially in telecommunications, airlines, banking, broadcasting, and food production. These changes would encourage foreign direct investment in all sectors, especially energy, banking, and telecommunications, and the lower prices from increased competition would benefit Mexican consumers.
The Mexican government should implement a substantial, multi-year infrastructure improvement programwith dramatically increased public and private funding of infrastructure development projects (e.g., privately owned toll roads),beginning with passage by the Mexican Congress of the ambitious infrastructure program recently proposed by President Calderón.
The Bush Administration, through the U.S. Department of Justice, should investigate the operations of Mexican monopolies in the United States, especially in the telecommunications, transportation, and energy sectors. The Justice Department should produce a report for the President that identifies those monopolies and lays out any actions that the U.S. government can take to encourage these companies to support the creation of viable domestic and foreign competitors within their economic sectors in Mexico.
The Bush Administration, through the U.S. Department of the Treasury, should commission a study by an independent private consultant to determine the level of remittances in all forms that are sent to Mexico from migrants in the U.S.
The Bush Administration should negotiate with the government of Mexico to design new co-funded assistance programs focused on intensive infrastructural, developmental, and technical assistance in those areas within Mexico that are the major sources of immigration to the United States.
The Bush Administration should negotiate with the Mexican government to design new assistance programs in conjunction with leading U.S information technology and adult-education companies with the goal of improving educational opportunities in Mexico through greater access to technology and information resources. Private U.S. companies should provide the bulk of funding for the projects in return for access to the Mexican market, to be negotiated with the Mexican government.James M. Roberts is Research Fellow for Economic Freedom and Growth in the Center for International Trade and Economics (CITE), and Israel Ortega is a Senior Media Services Associate in the Media Services Department, at The Heritage Foundation. CITE Research Assistant Caroline Walsh made many valuable contributions to this paper.
 Joel Kurtzman, "Mexico's Job-Creation Problem," The Wall Street Journal, August 3, 2007, p. A9, at
 Author's recollection from service at the U.S. Embassy in Mexico City, 1982-1984.
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 Stephen Labaton, "Int'l Business: F.C.C. Says Sprint and Telmex Overcharged on Some Rates," The New York Times, November 25, 1998, at
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 Eduardo Porter, "Mexico's Plutocracy Thrives on Robber-Baron Concessions," The New York Times, August 27, 2007, at
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 "Monopoly Money," The Economist, November 18, 2006.
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 Helen Coster, "Mexican Billionaire Expands Telecom Holdings," Forbes, April 3, 2006, at
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 Mehta, "Carlos Slim, the Richest Man in the World."
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 Kerry A. Dolan, "Rooting for the Home Team," Forbes, September 11, 1995, p. 121.
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 Jonathan Clark, "Users Decry Decline in Service," El Universal, May 8, 2005, at
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 Ibid., p. 2.
 Anthony DePalma, "Telmex Gains in Attempt to Buy Cable-System Stake," The New York Times, June 22, 1995, at
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 Economist Intelligence Unit, "Mexico Risk: Infrastructure Risk," Country Briefing, November 15, 2007.
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 "Reforms at Last," The Economist, September 20, 2007.
 Mehta, "Carlos Slim, the Richest Man in the World."
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